Tuesday, August 02, 2011

Superannuation Standard Risk Measure

After the global finance crisis, the Association of Superannuation Funds of Australia, in conjunction with other industry bodies, has issued a Standard Risk Measure Guidance Paper For Trustees (July 2011). This proposes a seven point scale indicating the estimated risk of negative annual returns over a 20 year period, from 1 being the lowest to 7 the highest. There is a standard phrase to describe each level and a standard set of words describing the measure.

The use of numerals for both the bands and the descriptions is confusing, as an example "5" being described as "3 to less than 4" is confusing. Letter could have been used for the band ("E" rather than "5"), or the numbers in the description replaced with words ("three to less than four"). Displaying the maximum estimated number of negative annual returns would also make the table simpler, with "3 to less than 4" replaced with just "four".

A seven level scale is probably too complex for the average investor and one having five or three levels would have been more usable. Also I suggest the industry could add a standard set of colors and symbols for the levels.

Risk BandRisk LabelEstimated number of negative annual returns over any 20 year period
1Very LowLess than 0.5
2Low0.5 to less than 1
3Low to medium1 to less than 2
4Medium2 to less than 3
5Medium to high3 to less than 4
6High4 to less than 6
7Very high6 or Greater

There is a standard description of the measure:
The Standard Risk Measure is based on industry guidance to allow members to compare investment options that are expected to deliver a similar number of negative annual returns over any 20 year period.

The Standard Risk Measure is not a complete assessment of all forms of investment risk, for instance it does not detail what the size of a negative return could be or the potential for a positive return to be less than a member may require to meet their objectives. Further, it does not take into account the impact of
administration fees and tax on the likelihood of a negative return.

Members should still ensure they are comfortable with the risks and potential losses associated with their chosen investment option/s.

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